James Daley

By James Daley

Regulating markets effectively can be an impossible job. As the free market followers will remind you - regulation distorts, fixing one problem but often creating others. Nevertheless, sitting aside and letting the market have its way often leaves the most vulnerable to get washed away with the tide. Sitting back and leaving consumers to learn their lessons the hard way is not consistent with the kind of society that most of us want to live in.

The payday lending market is quite a phenomenon. Over the last five years it exploded, as firms like Wonga made effective use of technology to offer loans to customers within a matter of minutes. The cost for that convenience was high, but lenders rightly claimed that few people walked into payday loans without understanding the cost. The growth in the market was, according to the industry, simply unmet demand - borrowers who weren't being serviced by banks and other lenders. Were it not for payday lenders, then borrowers would have ended up in the arms of illegal loan sharks.

Radical regulation

When the Financial Conduct Authority took charge of regulating the credit industry earlier this year, it had to make sense of these persuasive arguments, at the same time as listening to an increasing clamour from consumer groups and politicians to regulate the payday lending market to within an inch of its life.

Today, it concluded the first round of its work, by announcing the introduction of a price cap that will asphyxiate most of the industry to extinction. From January, lenders will no longer be able to charge any more than 0.8% interest a day - that's 80p for each £100 borrowed. And the total cost of credit will never be able to exceed 100%.

This is the heaviest piece of regulation the financial services industry has ever seen. Combined with the FCA's insistence that lenders go back and review previous lending decisions - and refund interest and fees to people who should never have been lent to - it is likely to wipe out all but a handful of companies in this market. And those that survive will have to accept a fraction of the margins that were available to them in the past.

A proportionate response? Possibly not. But if the distorting effect of its actions is that this industry all but disappears, it will ultimately be good for consumers - whether they like it or not.

Politicians weigh in

I'm fairly sure that the FCA would not have gone for anything nearly as drastic had it not been bounced into a price cap by politicians. But having now entered new waters, my hope is that it will be brave enough to carry this kind of thinking through into other sectors. Within the lending market, overdrafts and equity release need another good look at - while the FCA has already passed up chances for some radical solutions to solve pricing and transparency problems in the insurance industry. It should revisit these with a braver approach as well.

It will no doubt want to see how things bed down with payday loans first - but I'm willing to bet that the kind of consequences predicted by the industry will never materialise.

The growth of black market lending is not something to be taken lightly. There is no protection for consumers, and borrowers are often subjected to physical violence or threats to themselves and even to their family if they do not pay up.

But illegal loan sharks were not a massive problem in the UK before the advance of payday lending, and it's hard to believe they will be once the industry has been scaled back. Although the headlines today are all about the FCA's price cap, the real danger of payday loans was the ease with which people could get their hands on them. As the industry are forced to do more data sharing, and more rigorous affordability checks, it should get much harder for people to get their hands on credit if they can't afford it.

Before payday loans existed, people who couldn't get access to credit were more likely to turn to their family or friends for support - or to seek professional debt advice. Often, payday loans merely delayed the inevitable, keeping people solvent for a few extra months, and leaving them in a worse position when things fell apart. In other cases, borrowers were tempted to instantly gratify themselves - using payday loans to buy the phone or holiday that in the past they would have been forced to save up for. The instant nature of payday loans meant that people often didn't pause for thought.

As much as anything, the new regulations are about protecting people from themselves. That might seem paternalistic, but few would now disagree with the law that forces you to wear a seatbelt, or the ban on tobacco advertising. For those who can afford payday loans and understand the costs and risks, the option will still be there.

Today is certainly a watershed moment in terms of Britain's approach to financial services regulation. Our fear of hands on regulation has created a financial services market where mis-selling scandals have been a permanent fixture of the landscape, and the clean up job has too often been done retrospectively. Things are finally changing.